Phoenix Group The Phoenix Group has been in business for a number of years as a retailer of a wide variety of consumer

products. The Group operates from a number of stores around the U.K. In recent years it has found it necessary to provide credit facilities to its customers in order to maintain growth in turnover. As a result of this decision, the liability to the Groups bankers has increased substantially. Extracts from the financial statements for the three most recent years are: P&L a/cs for the years ended 31 December 2010 2009 000 000 Turnover 2,500 2,200 Cost of sales (1750) (1,500) Gross Profit 750 700 Other operating costs (700) (640) Operating profit 50 60 Interest receivable 90 60 Interest payable (110) (60) Profit before taxation 30 60 Taxation (10) (20) Profit after taxation 20 40 Dividends 15 12 1590 1392 Retained profit 10 2008 000 1,850 (1,250) 600 (550) 50 45 (25) 70 (23) 47 12 1182 70

Balance Sheets as at 31December 2010 000 322 620 633 15 1590 280 8 20 610 672 320 352 Share capital Reserves 90 262 352 2009 000 290 540 550 12 1392 270 20 30 520 552 200 352 90 262 352 2008 000 278 400 492 12 1182 270 20 30 320 542 200 342 90 252 342

Tangible Fixed assets Current assets Stock Debtors Cash Current liabilities Trade creditors Tax Proposed dividends Bank overdraft Debentures

Other details are as follows: i) debentures of 200,000 are due to be repaid in July 2010 ii)The maximum lending facility the bank will provide is 630m. iii)The company offers extended credit terms for certain products to maintain market share in a highly competitive environment.

Given the steady increase in the level of bank loans which has taken place in recent years, the company has recently written to its bankers to request an increase in the lending facility. The bank is concerned at the steep escalation in the lending requirements, and has asked for a report on the Groups finances. You are required to: a) Prepare a report for the bank which analyses the financial performance of the Group for the period covered by the financial statements. You are required to pay particular attention to those aspects of performance that may have contributed to the increased borrowing requirements.

Phoenix Group Solution Report To: ABC Bank

Date: 21.10.09 Subject: Financial performance 2006-8

This report has been commissioned to review the performance of the phoenix Group for the years 2006-8 and will look at the following aspects in turn; profitability, liquidity, efficiency and investor ratios. All calculations are included in Appendix A. Profitability Gross profit and net profit% are falling despite an increase in sales; this suggests that the company has possibly reduced the selling price to stimulate sales (sales have increased by 18.9% from 2006-7 and by 13.6% in 2007-8) or the sales mix has changed so that more low margin items are being sold. The increase in sales has also been achieved by relaxing credit terms, but this has created credit control problems as demonstrated by increase in debtor days. ROCE has fallen by 3% which reflects the fall in profitability. This coupled with the halving of the ROE will greatly concern shareholders as their investment is earning considerably less. This should concern us as a bank because if profitability and shareholder confidence fall then the potential of this company to generate future profits may be affected which might make our investment increasingly risky. Liquidity The ability of this company to repay our loans is our main concern and thus its liquidity position is of paramount importance. The current and quick ratios have remained consistent and although both are lower than the 2:1 and 1:1 that would generally be looked for they are not indicating any major short term liquidity problems in themselves. However, the company has become increasingly reliant on short term borrowing from us (probably to cover the increased credit sales that they have been making on, what would appear to be, terms that are

far too generous) and they are now dangerously close to their 630K limit. This is very worrying given that the company is due to repay debentures of 200k in July 2010 and it really begs the question as to where the company is going to raise this money? Further concerns are raised if we consider the long term liquidity of the company; the debt:equity and gearing ratios show that the company is reliant on external sources of funding which, given that the main source of this, the debenture loans, are not held by the bank which consequently means we have no fixed charges on the company makes this company appear to be a very risky partner. As a result of the debentures and the existing bank loans the company has to pay a great deal of interest- in fact in the current year the company did not make sufficient profits to cover the interest, a situation which is very worrying. If the debenture holders are not paid interest they are entitled to force the company into liquidation and we may find that the remaining capital does not cover the money owed to us. Furthermore working capital management appears to worsen the situation- creditor days are lower than debtor days which means the company is relying on us for short term as well as long term funding, a situation which must be rectified as a matter of urgency. Efficiency It goes without saying that this company is not very efficient its working capital management is appalling and its liquidity position would improve immediately if the company took steps to shorten debtor days (revise its generous credit terms for one thing) and lengthen creditor days.

Appendix A Ratio Calculations. Gross profit % Net profit % ROCE Current ratio Quick ratio Stock turnover Debtor days Creditor days Return on equity Debt/equity ratio Gearing ratio Interest cover EPS Dividend cover 750/2500 * 100 30/2500*100 50/672*100 1268/918 1268-620/918 1750/620 633/2500*365 280/1750*365 20/352 320/352 320/352+320 50/110 20/90 20/20 2008 30% 1.2% 7.4% 1.38:1 0.7:1 2.8 times 92 days 58 days 5.7% 91% 48% 0 22p 1 times 2007 31.8% 2.7% 10.9% 1.31:1 0.7:1 2.8 times 91 days 66 days 11.4% 57% 36% 1 33p 1.33 times 2006 32.4% 3.7% 9.2% 1.41:1 0.8:1 3.1 times 97 days 79 days 13.7% 58% 37% 2 33p 1.56 times